Is stock trading the quickest way to build wealth?

Trading on the stock market is not a straightforward way to build wealth. (Pixabay pic)

To many, stock trading appears to be a good way to increase one’s income in order to build wealth without too much hard work.

But it is not as easy as it looks and there are other ways to increase one’s income that have added benefits.

Here are four considerations to help decide whether or not trading in stocks is the way to go.

1. Time

If one is new to stock trading, it is better to start by learning how to trade first. This involves learning about technical analysis, which is the study of stock price patterns and the technical tools to guide one in making profitable trades – timing one’s entry into and exit from the market.

The tools include the simple moving average, exponential moving average, relative strength index, stochastic, oscillators, MAC-D, volume-weighted moving average and the list goes on.

A beginner might be overwhelmed by these tools for it is not easy for most people to master them.

Depending on one’s level of intelligence and dedication, it could take a few months (the fastest) or a few years (for most) to really fine-tune their stock trading skills.

So, the question is, how passionate are you about stock trading?

2. Profit

Is learning about technical analysis a guarantee of stock trading profit or, at least, not losing one’s trading capital? The answer is no. Not even the best traders in the world can make such a guarantee.

Trading losses are part and parcel of stock trading. Differentiating between good stock traders and those who are not, relies on two metrics:

  • Win-loss ratio. A stock trader has made six winning stock trades in his 10 most recent trades. The win-loss ratio is therefore 60%. That is not too bad, right? Not exactly, which is why a look at the next metric is important.
  • Gain per winning trade and loss per losing trade. If the gains on the six winning trades exceed losses incurred on the losing trades, then, the individual is a good trader as they have made a net trading gain.
To many, investing in the stock market seems like being in a casino. (Pixabay pic)

But, if the gains on the six winning trades are less than the losses incurred on the four losing trades, then the individual is not a good trader as they have a net trading loss.

Stock trading is about probability and with that, the question is: can one stomach occasional trading losses?

3. Will you up your trade?

After spending time and energy to acquire the skills and one has the ability to earn RM2,500 a month from RM50,000 in trading capital with transactions of RM5,000 for each counter, given RM500,000 in trading capital, would the individual raise their trading amount to RM50,000 per counter for each transaction?

Some might see this as risky. What if this trade is a mistake? Would the individual stand to lose some trading gains from the past 100, 200 or 500 trades? To some, this might seem a little like being in a casino.

The question now becomes if one is 30 years old and will be trading RM5,000 a time into each counter in order to flip it for a trading profit of RM2,000, RM3,000, or RM5,000, when they near retirement age, is this what they want?

It feels good initially when one doubles one’s capital from RM5,000 to RM10,000 in a short period of time. Some would even take the RM10,000 and try to double it to RM20,000.

But, even if that was successful, one could be reluctant to trade RM20,000 and turn it into RM40,000 due to the fear of losing the initial trading profit.

If the individual is not willing to up their trade, they will remain a trader who makes a few thousand ringgit here and there for a lifetime, even if they are earning 50%, 100% or 200+% in gains per winning trade, simply because they do not have the volume.

There is a science to be learnt in analysing share price movements and one must have a certain skill. (Rawpixel pic)

4. What is the best choice?

Say two people earn RM5,000 a month from their day jobs. “A” is committed to learn about stock trading at night and two years later, “A” is earning RM5,000 a month in trading income, boosting his monthly income to RM10,000 a month.

“B” chooses to start a small part-time business. Two years later, B has doubled his income to RM10,000. Is there a difference between the two?

Yes, there are many differences, and here is just one of them.

A and B apply for a mortgage from the bank. How will the credit officer view them as potential borrowers, despite each earning RM10,000 per month?

From the banker’s viewpoint, A’s income is still RM5,000 a month as the bank does not view income from stock trading as a reliable source of income.

B would qualify for a significantly higher mortgage than A as the bank views B as earning RM10,000 a month from employment and business income.

Based on the bank’s acceptable debt-service ratio (DSR) of 60% and the Rule of 200, B’s extra income of RM5,000 is equivalent to RM600,000 in extra property mortgage.

The formula to calculate is as follows: extra property mortgage = (extra monthly income x DSR) x 200 = (RM5,000 x 60%) x 200 = RM 600,000.

In short, one should start a part-time business or invest in learning to enhance one’s career to boost monthly income, which are leverageable via mortgages that can be used to buy investment properties, rather than learning how to do stock trading because the trading income earned is not leverageable.

Conclusion:

While stock trading seems like a fast method to generate more income, it could be a slow train to build wealth even if one has spent time and energy on learning how to do it.

The better approach would be to invest in oneself to increase one’s employment income. Or, start by learning how to do business by opening a small enterprise that can be expanded to something bigger in the future.

This article first appeared in kclau.com

Ian Tai is the founder of Bursaking.com.my, a platform that empowers retail investors to build wealth through ownership of fundamentally solid stocks. It is an essential tool that sifts out stocks that grow profits consistently from a database of over 900+ stocks listed mainly in Malaysia.